It probably won’t surprise you to know that locally owned / family-owned businesses are good for the economy and good for the community as a whole.
The sale of your business, and the subsequent trajectory of its future, affects more than just those directly involved in your company. Your company’s future affects the surrounding community, making the task of finding the right buyer that much more important.
How do family-owned businesses affect the local economy?
We all know local businesses are important. But how exactly do they affect the economy differently than larger corporations?
Grand Valley State University’s Family Owned Business Institute took a survey in 2014 assessing how family businesses operate within the local economy. Of course, this study was specific to West Michigan, but it’s safe to assume that many of these nuances are similar in other communities as well. Here are some highlights of what GVSU’s study found:
- Local business owners generally operate with a sense of loyalty to the overall community and to their employees. In times of economic downturn, layoffs are a last resort taken by most family-owned businesses. In fact, it’s typical for owners to take a cut in their distributions and/or salaries, followed by trimming the fat in other areas of the company’s budget, before jobs are affected.
- More than half of locally owned West Michigan companies do business with suppliers within the state of Michigan, so more capital stays within the Michigan economy.
- Locally owned businesses tend to do more philanthropic giving within their communities than non-locally owned businesses.
What are different options for selling your business, with the long-term trajectory of the local community in mind?
Option 1: Private Equity
First, let’s talk about what types of buyers that you may want to strategically avoid if your goal is to keep your business local even after you’re out of the picture. First, a disclaimer: it’s going to sound below like we are ragging on private equity (PE) when that is not the intention. We like private equity buyers and oftentimes private may be the only option for a seller.
For example, consider that over 30 years a seller has grown their business from a garage to $5MM in EBITDA. Even if they have children in the business, it will be highly unlikely that the children will have the means to buy the business in any fashion that is palatable to the owner (ex. the owner finances the entire transaction). In this circumstance, the seller can partner with private equity, take a significant amount of chips off the table, and the children can retain and often gain smaller amounts of equity in the business. However, ultimately, PE’s loyalty is going to be to the money. Whenever the business isn’t aligned with the money, they will side with the money.
Companies in the $5-50 million dollar valuation range are the most likely to be sought after by private equity firms. These buyers also tend to come from out of state, typically 100 miles or more from the business’ home base, making the investment group far less likely to feel a bond or sense of duty to the community.
Private equity firms are generally return-seeking, and aren’t as emotional about job cuts, keeping a business in the community, or continuing the legacy of the founder. They’re also more likely to consolidate locations, for example, when they make bolt-on acquisitions, specifically because they’re looking for ways to generate monetary returns for their investors, and then sell up the food chain at a higher earnings multiple within 5-7 years. While PE firms can sometimes be the fastest cash-in-hand option for a seller, they’re not often the best in terms of keeping the Company local and on a trajectory to continue serving the local community for the long haul.
Again, we are not passing judgment or trying to be harsh regarding private equity. It’s just that when it comes to people or items that have long been considered protected interests of the owner, those things are not going to last long with a PE buyer.
Option 2: ESOP
So what option does this leave, for locally owned companies in this $5-50 million financial bracket? This is where a business owner might consider an ESOP. ESOPs, or Employee Stock Ownership Plans, are a way for the owner to sell portions of their company to the company’s employees.
ESOPs keep your business locally owned, and they can often boost employee morale, because the employees have more skin in the game, and they have increased motivation to see the business thrive and grow. There are definitely some major success stories from business owners who chose to utilize an ESOP.
However, while ESOPs are great for keeping a business locally owned, and can be a viable option for larger businesses (generally, 40+ employees and $2 million or more in annual revenue is the minimum baseline), they may not fit with every business owner’s personal objectives. If you want a high valuation, ESOPs don’t always bring you a large influx of capital, especially considering that they themselves can require a large investment to set up and maintain. They’re also not the best option for the business owner who’s hoping to get out of the ownership role relatively quickly, as they tend to require a transition period of a few years, and can often require a significant amount of time sourcing and developing a new leadership team. Additionally, many conservative owners who are not used to debt have trouble leveraging the company to be bought out at a lower price than they would likely receive on the market.
Option 3: Selling to Children/Key Employee
If you already have a successor in mind, such as a specific employee/manager, or a son or daughter, selling to your “natural” successor can be a great way to keep your business within its community and to continue the original founders’ legacy and name.
Selling to a child or a similar type of successor is best done with a lot of preparation and planning, as well as a good level of transparency with your successor. A pitfall that a lot of business owners fall into is choosing a successor who is underprepared for the role of ownership, and the business doesn’t continue to thrive after it’s been acquired. Another hitch you may run into is that if you’re looking to use the sale of your business for retirement, if you choose to finance a sale to your successor, you may find yourself heavily self-financing the business, to the point where you’re not able to feel the relief of the sale or enjoy the economic rewards to the extent that you had hoped.
However, a significant percentage of West Michigan businesses are owned by a second, third, or even fourth-generation owner. While this doesn’t give a solid sampling of other areas, it shows that, at least for West Michigan, family businesses are a big part of our culture, which perhaps bodes well for continued family succession in Michigan businesses. A key component is making sure your successor is fully on board and as prepared as they can reasonably be for continued success.
Option 4: Selling to an Individual Investor
A final option and one that business owners don’t always realize is an option, is finding a buyer in the form of a local individual investor. There are plenty of individuals looking to purchase a company that they can run and grow themselves, but without having to start a company and build it from the ground up. In fact, in 2020 YTD, of the 30 deals that Calder has transacted, 16 have been with individual buyers. Especially for small companies, individual investors are often preferable over private equity firms, because PE firm acquirers at the “bolt-on” level are more likely to buy small companies for the sake of efficiencies gained in consolidating them.
Individual investors are more likely to be local and stay local. Particularly in Michigan, where a lot of folks have roots that go back several generations, the legacy of your business has a good chance of being preserved. With an individual investor, there’s also the absence of family dynamics which, while good for some acquisitions, can complicate others. Purchases by individual investors don’t necessarily need to be as heavily owner-financed. In fact, it’s relatively uncommon for the owner to finance more than 20% of the sale to a 3rd party buyer. And you can, to an extent, hand-pick a buyer whose vision melds with yours, and for whom your company fits their acquisition criteria.
To conclude, there are often many more options for exiting a business than owners first consider. We encourage you to take time and start discussing your options early, often years before you want to exit from the company.
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